Business Finance

Understanding the S&P 500

Written by Bennet Grill for Gaebler Ventures

Like the "Dow," the price of the S&P 500 is often mentioned on news reports when the stock market is discussed. What exactly does the S&P 500 represent, and what does it mean for business owners and entrepreneurs? This article outlines the historical significance of the S&P as well as its current role in financial markets.

Standard & Poors is a financial information services company whose roots can be traced back to publications in the mid 19th century.

As a business owner or entrepreneur, it is important to understand the significance of the S&P 500. The S&P 500 is an index of 500 large market cap companies which are often pointed to as indicators of the United States economy (although there are 5 foreign companies included in the index.) The S&P 500 can trace its roots back to 1923, when the S&P 90, an index linked to 90 publicly traded companies, was introduced by Standard & Poors. In 1957, the S&P 500 inherited its current number of 500 companies. Today, the S&P 500 represents about 75% of the market capitalization of the stock market.

Stocks are chosen to be represented on the S&P 500 thorough a selection committee. Instead of including the 500 largest companies (the metric for the Fortune 500,) Standard & Poors considers the role of the company in United States industry, whether or not a company is publicly traded, and the liquidity of the company's shares (how often the stock is traded on the market.) The value of the index itself is calculated by an algorithm which takes into account the shares outstanding of each company. Instead of being weighed strictly according to market value, the S&P is float weighed, which accounts for the number of shares available to the public for trading.

The S&P 500 is often touted as an important indicator for the United States economy. In fact, it is the only equity component of the Leading Economic Index (LEI), a marker published by the Conference Board used to forecast economic performance of the United States.

One remarkable feature of the S&P 500 is its correlation to the Dow Jones Industrial Average (DJIA). Despite the fact the Dow includes only 30 companies, the long run correlation between the S&P 500 and the DJIA has been shown to exceed 95%. Often times, when a stock is selected to be included in the S&P 500 or DJIA its share price rises because many money managers buy the entire S&P 500 or DJIA index.

It is an important indicator of the direction of the United States' economy and represents over 75% of the market capitalization of the stock market.

Bennet Grill is a writer who has a passion for business and finance. He is currently an Economics major at Duke University in North Carolina.

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